How Will Congress’ Fiscal Cliff Compromise Impact Your Taxes?

Although Congress’ post-last-minute tax compromise managed to avert most of the ramifications of the so-called Fiscal Cliff, the actual legislation passed will result in tax increases on almost three in four Americans. Below is a high-level look at the implications of the new law for investors at all income levels.

What you should know:

1. The majority of Americans will pay more this year. One of the most frequently criticized implications of the new legislation results from something that was not a part of it – the bill did not extend a 2% Social Security tax holiday that was enacted in 2011 and expired after 2012. Other increases specifically included in the law will take an even larger tax bite from some:

Couples with taxable income over $450,000 and single filers over $400,000 will see that additional income taxed at 39.6% (up from 35% in 2012).

Those same filers will pay 5% more on dividends and long-term capital gains (20% vs. 15% in 2012).

Couples with a taxable income over $250,000 or individuals over $200,000 will be subject to an additional 3.8% Medicare tax on investment income.

2. Many temporary credits, deductions and exemptions were made permanent. While paychecks will be smaller for most American workers this year, so will their overall tax liabilities thanks to the permanent extension of the Bush-era tax cuts for most taxpayers. Other extensions include:

The child tax credit will remain at $1,000 per qualifying child, rather than falling to $500.

The 10% and 15% tax brackets and the standard deduction for married couples will remain twice that of single individuals, reducing the so-called “marriage penalty.”

The $5 million threshold for exemption from the estate tax remains in place (though the tax on estates above that amount has increased to 40%.)

The Alternative Minimum Tax was permanently “patched” and inflation adjusted, minimizing the number of taxpayers impacted.

Several other expired or set-to-expire provisions related to education savings, charitable giving and business costs have been extended as well.

3. “Permanent” may be a misleading term.While the new law provides some much-needed certainty around taxes – something many investors and businesses had long been waiting for – that certainty may be short-lived:

The new law is expected to generate $600 billion in new revenue over the next ten years – well short of the president’s stated goal of $1.6 trillion.

The United States hit its debt ceiling at the end of 2012, and Republicans have promised to fight for spending cuts before raising it again – which could bring taxes back into play if the president stands by his past insistence that new revenues accompany new cuts.

What you should do now:

With what we now know, your Financial Advisor is much better positioned to help you plan. We recommend you schedule a meeting or call soon to assess the implications of new tax rules for your specific situation and investment strategy.

For more comprehensive information on the recent changes to U.S. tax law and their implications for investors, visit rwbaird.com and search “managing taxes.”